The World Federation of Exchanges (“WFE”), the global industry group for exchanges and central counterparties (CCPs), has published a joint report with Oliver Wyman examining the post-crisis developments that have shaped the current clearing landscape, along with forward-looking recommendations on how to build the CCP of the future.
Welcome to 2019 - The OTC Space has been busy with other projects, but I couldn't miss passing on this one from ISDA. Does anyone else find it interesting that ISDA has taken on the role of reminding CCPs how to do their job properly?
I would think regulators themselves should be reminding CCPs of these sensible guidelines. Given the flood of clearing regulations, is there some doubt that CCPs can do their job?
The justification for the ISDA reminder are two defaults, both from the Exchange traded side of the market. Given the complexity of OTC products, the world has turned when the OTC guys started reminding the ETD guys how run a CCP.
Let's hope CCPs are reading this blog post - help us sleep soundly and enjoy the excitement of Brexit!
Two central counterparties (CCPs) have experienced clearing member defaults over the past five years that have exceeded the defaulting member’s contribution to default resources and required the use of mutualized resources in the default fund, spreading losses to other CCP participants. These defaults – which occurred in the futures segment of the Korea Exchange and, more recently, at Nasdaq Clearing in Europe – have highlighted weaknesses in some CCP risk management practices and underscore the importance of a more consistent implementation of risk management best practices by CCPs around the world.
This paper outlines ISDA’s current thinking on clearing risk management best practices. Fundamental to these practices is the principle that CCP risk management decisions should be based on the risk profile of a given derivatives product. These best practices call for a holistic, multifaceted and dynamic product-based approach. It is insufficient to rely on a single risk factor as the determinant for exposure – for example, whether it is classified as an exchange-traded or over-the-counter (OTC) derivative. As markets evolve, risk management must also adapt.
ISDA and its members call for broad-based implementation of these best practices to ensure that CCPs have:
Risk controls and margin requirements that adapt to concentration, liquidity, member credit quality and wrong-way risk in a member’s portfolio;
Effective and transparent default management processes; and
Robust membership criteria and greater assurances of continued adherence to them.
Most importantly, these practices will ensure that, outside of an extreme stress event, the default of a member will not be propagated to other members or the wider financial system.